Quick reply to Ryan Avent

Ryan Avent criticized my recent defense of Mankiw:

That tax rates are driving the disparity in incomes is belied by the very data presented in Mr Mankiw’s initial post. His computation uses four economies with per capita incomes clustered closely together: France, Germany, Britain, and Japan. But while per capita outputs in those countries are very similar, the revenue shares of GDP are wildly different, ranging from 46.1% for France to 27.4% for Japan. And of the four, Japan’s per capita income is the lowest.

At no time did I argue that tax rates drove the disparity between the incomes of all countries.  Indeed I cited the Congo and Afghanistan as examples of how that could not possibly be true in all cases.  I also contrasted Italy and France.  Rather I suggested that the disparity between Western Europe and the US might be largely driven by different tax rates.  I’m not the only one who has made that suggestion, Prescott has done studies that reached similar conclusions.  I seem to recall that when French tax rates were at US levels (about 50 years ago I believe) the French worked just as much as Americans.  If so, then this would seem to conflict with the argument that greater European leisure time reflects cultural differences. 

Ryan Avent continues:

Mr Sumner tries to get around that by saying that if it’s not taxes, well then it must be some other favoured policy of the left. And:

“Further evidence for this hypothesis is that the few developed countries that do have much lower tax rates than the US (Hong Kong and Singapore) now have much higher per capita GDPs (PPP) than Western Europe.  Yes, they are small and urban, but Western Europe is full of small countries of about 6 million people that have less than 5% of the population in farming.”

True. But Norway and Luxembourg are richer than Hong Kong, Singapore, and America, and they have higher tax takes as a share of output. It’s almost as if it’s foolish to just cherry pick pieces of data on revenues as a share of GDP versus per capita GDP in order to make a point.

Well if Singapore and HK are unrepresentative, then Norway and Luxembourg are even more unrepresentative.  Everyone knows that Norway is just Sweden with lots of oil.  Take away the oil and Norway would probably be no richer than Sweden and Denmark.  Oil extraction isn’t really “income,” it’s running down a stock of wealth.  And Luxembourg?  Why stop there?  Let’s include all the rich postage stamp countries–Bermuda, Liechtenstein, Monaco, etc.  Then check out the average tax rates in all those tax havens against the bigger countries.  The 4.5 and 7 million people of Singapore and Hong Kong puts them in the mix with Denmark, Norway, Switzerland, Finland, etc.  Luxembourg only has a few 100,000 people.  Maybe it’s a cultural difference, but Americans just don’t consider it a real country.   Having said all that, although Singapore and Hong Kong are better examples than the two cited by Avent, I’ll freely admit that they aren’t ideal examples—they have probably skimmed some highly talented people from their bigger neighbors.  (I’d guess Luxembourg has as well.)  My post suggested Mankiw had a defensible argument—not an airtight argument.

Avent continues:

But then Mr Sumner gets really deep into it, citing Texas the epitome of the American economic model and arguing that it is especially dynamic and successful based on the fact that its population has been growing rapidly while Americans have been moving away from “states with fiscal policies more to the liking of progressives like Yglesias and Krugman”. Certainly, Texas has its upsides. I noted earlier today that better regulation of mortgage lending helped the state avoid a debilitating wave of foreclosures (I suspect that both Mr Yglesias and Mr Krugman would approve of said regulation).

There are multiple problems with these arguments, but I’ll stick with just two of them. First, Americans are moving to Texas, but they’re also moving to lefty bastions like Boston and San Francisco, both of which enjoyed net domestic in-migration from 2008 to 2009, according to brand new Census figures. That’s right, they’re moving to what some refer to derisively as “Tax-achusetts”, even with the comprehensive health insurance coverage.

Boston is actually a lousy example as we have had a fairly stable population for decades, while Texas has been growing very fast.  Avent should have mentioned NYC, which has gained substantial population despite an even worse tax structure than Massachusetts.  I agree that if areas have outstanding amenities (like NYC and SF, and to a much lesser extent Boston) then they can extract rents from highly skilled people who appreciate their sophistication and the ability to interact with other highly skilled people.  But if you compare equals—an uninteresting manufacturing city in New York state and/or Massachusetts with an equally uninteresting manufacturing city in Texas—then it is very clear where people are moving.

Ryan Avent continues:

The second point is that Mr Sumner should familiarise himself with an important body of literature on housing markets and migration. I’ll just briefly quote real estate economist, Massachusetts resident, and conservative Ed Glaeser:

“In the last 50 years, population and incomes have increased steadily throughout much of the Sunbelt. This paper assesses the relative contributions of rising productivity, rising demand for Southern amenities and increases in housing supply to the growth of warm areas, using data on income, housing price and population growth. Before 1980, economic productivity increased significantly in warmer areas and drove the population growth in those places. Since 1980, productivity growth has been more modest, but housing supply growth has been enormous. We infer that new construction in warm regions represents a growth in supply, rather than demand, from the fact that prices are generally falling relative to the rest of the country. The relatively slow pace of housing price growth in the Sunbelt, relative to the rest of the country and relative to income growth, also implies that there has been no increase in the willingness to pay for sun-related amenities. As such, it seems that the growth of the Sunbelt has little to do with the sun.”

Neither does it have much to do with the brilliance of the Texan economic model. Rather, it seems that housing supply growth in places like Boston can’t keep up with high housing demand, which has led—just as economics predicts—to rapidly rising house prices. And rapidly rising house prices—just as economics predicts—ration population growth. Price sensitive households end up following housing supply growth, of which there is a great deal in the state of Texas. To put things simply, if there weren’t a high level of demand for housing in those oppressive Northeastern cities, then prices couldn’t be held at a level so much higher than those in Sunbelt states. But the price differential remains.

Yes, I am very familiar with Glaeser’s work, but Avent is responding to an argument I never made.  I was touting Texas, not the Sunbelt.  Texas isn’t just doing better than its neighbors (Oklahoma, Arkansas, Louisiana, Mississippi, New Mexico, etc), it is doing dramatically better.  And all those states I just mentioned are warm and have plenty of available land and very low housing prices.  They also have income taxes, something Texas lacks.

Ryan Avent concludes:

To summarise: it’s often unwise to cite a few misleading data points in defence of a sweeping argument about economic dynamism.

My focus was the supply-side effect of taxes; I freely admit that lots of other government policies affect growth, and that Texas has some of those other good policies.  I believe that bad non-tax policies partly explain Japan (along with a very inefficient tax system.)  Here’s my challenge to progressives (not necessarily Avent, I don’t know his views.)  Progressives tend to be skeptical of the supply-side argument that higher taxes sharply cut real GDP growth.  Let’s suppose the US raises its average tax rates to French levels (from .282 to .461.)  Without behavioral changes, that increase should raise tax revenue (PPP) from $13,097 to $21,410.  Out of the hundreds of countries in the world I want some progressive to find just one that is bigger than a postage stamp and doesn’t rely heavily on oil exports, and which raises even close to $21,410 per person.  I claim it can’t be done, and I claim the reason it can’t be done is that (unless one is blessed with large oil deposits) the Laffer curve peaks at a level much lower than $21,410 (for whatever year Mankiw used in his data.)  My hunch is that Denmark and Sweden are near the peak.  And I doubt the US would even be able to match their tax take.  Apart from taxes, those two countries actually have pretty efficient economic models.

HT:  Dilip.  I guess my reply wasn’t so “quick.”


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6 Responses to “Quick reply to Ryan Avent”

  1. Gravatar of Tourist Tourist
    2. April 2010 at 07:54

    [OK ... I commented this at a previous post but was late to the writings ... "first time caller" hoping it's OK.]

    No. Mankiw would probably not press hard the Laffer curve which I would say is theoretically possible in a certain context, but generally doubtful for practical economic policy planning. Just by way of example, it is possible but for Reagan’s tax cuts, US tax revenues from 1982 (or 1986) until 2010 would be less. And further, at some point, marginally, it MUST BE so that lower taxes increase government revenue, i.e., 100% taxation … right? So, that’s complicated.

    I think Mankiw is making the argument without really considering it that wrecking GDP in itself is bad public policy for a nation … which it is. And raising taxes that depress GDP hits the poorest the hardest in however subtly invidious ways even if the government gains short-term tax revenue increases.

    For every 1% GDP increase over 50 years, a society is 64% wealthier [better check my math]. Can you imagine how much worse off we’d all be, particularly the poor, if the USA were 64% poorer since 1960? And how much we suffer for our GDP dwindling on average since the 50s/60s from 4% to kind-of 2.25% … for whatever reason, but noting government was 14% of the GDP in the 1958 and I think about 30% now [again, better check my data].

    [This is new.]

    That’s so far fewer jobs, but beyond that, so much less free-capital driven innovation … and beyond that so much less of a tax base from which to fund public everything: national defense, hospitals, schools, police, infrastructure.

    Also … please … the only reason Europe (and China, etc.) have the GDP in absolute terms or in GDP growth they have is they cope USA technological innovations in medicine, engineering, computers, etc. driven by our … compared chronologically and internationally … excellent, for now, republic. Where would France be without us on any level? Or Earth?

    Tourist

  2. Gravatar of scott sumner scott sumner
    2. April 2010 at 08:26

    Tourist, Some of your data is wrong (government was much more than 14% of GDP in 1958) but you do have some good points. High taxes can reduce growth. Don’t confuse the Laffer curve with the issue of whether higher rates raise revenue. Many people wrongly think you want to aim for the top of the Laffer curve. In fact, the deadweight loss from the last dollar raised becomes infinite at the top.

  3. Gravatar of Mark A. Sadowski Mark A. Sadowski
    2. April 2010 at 08:49

    Just a friendly nitpicking one more time: the OECD tax burden figures are 0.283 and 0.436 (significantly different, n’est pas?) for US and France respectively. Until we know where the Heritage Foundation’s figures come from they should not be used. I think I can safely say if you try to use them in a research paper it will not pass review.

  4. Gravatar of A quick reply to Scott Sumner – Economics - A quick reply to Scott Sumner - Economics -
    2. April 2010 at 09:54

    [...] SUMNER has replied to the post I wrote yesterday, and I just want to make a few additional points. He writes:At no [...]

  5. Gravatar of Tourist Tourist
    2. April 2010 at 18:32

    Scott Summer et al.

    Thank you …

    http://www.cato-at-liberty.org/2010/02/01/five-decades-of-federal-spending/

    I stand corrected and grateful for it. I have federal spending at 18% of GDP in 1960 and steadily and now at a far more accelerated rate to 25% in 2010 based upon this graph and roughly adding it up. I erred on both sides in my hubris and haste. In the 60s average GDP growth was 4.4%, in the 00s, 2.1%: http://www.gongol.com/research/economics/gdpgrowth/.

    I note with confidence that the 90s up-tick can only be credited, if at all, with the Reagan tax cuts since Clinton barely raised the across the board taxes from their 1986 level. By my rough reckoing, Reagan cut federal taxes, with a few targeted policy-related increases notwithstanding, 25% across the board;Bush I raised them, across the board, maybe 1%; Clinton raised them, across the board, maybe 2%; and Bush II cut them about 6%, making the tax system counter-intuitively more progressive, by the way: too tired to find the graph, but it is so with great confidence.

    What is absurd to me is for all the vitriol quietly foisted on Reagan, not one politician, whatever party, calls for restoring the Carter-era federal tax regime.

    Thanks again, docs.

    Tourist

    I have to study your post more; I was an economics and political science student at one time but it was a while back. I think you addressed my point, but in any case, there is no way to be sure if Reagan’s tax cuts did not merely raise GDP, but according to supply-side economics, would their hopes be realized, also raised tax revenue, from 1982-2010. The counter-factual does not exist, i.e., if the recession were prolonged and had their been thus missed whatever actual multiplier effect there was [Microsoft began in 1982 if I have this fact right]. All economists have are models that guess what a given tax cut has caused in terms of short, medium, and long term tax revenue. Hypothetically, the actual Laffer curve in a given time and place is incalculable, however statistically it might be conjectured. I don’t say you ought to aim for the top of the Laffer curve [still considering what you wrote]; I say you can’t ever know it previous to tax policy or even in hindsight; nor, concurrently, it’s slope.

  6. Gravatar of ssumner ssumner
    3. April 2010 at 07:50

    Mark, Thanks. I added an update at the end of my newest post.

    Tourist, I addressed your comment in another post.

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